ALLOCATING COSTS OF SUPPORT DEPARTMENTS AND JOINT PRODUCTS CHAPTER © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER OBJECTIVES Describe the difference between support departments and producing departments Calculate charging rates, and distinguish between single and dual charging rates Allocate support center costs to producing departments using the direct method, the sequential method, and the reciprocal method © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER OBJECTIVES Calculate departmental overhead rates Identify the characteristics of the joint production process, and allocate joint costs to products © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use AN OVERVIEW OF COST ALLOCATION • Common costs are mutually beneficial costs • Occur when the same resource is used in the output of two or more services or products • May pertain to periods of time, individual responsibilities, sales territories and classes of customers LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use AN OVERVIEW OF COST ALLOCATION • A means of dividing a pool of costs and assigning those costs to various subunits • Does not affect the total cost • Amount of cost assigned to the subunits can be affected by the allocation procedure chosen LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use AN OVERVIEW OF COST ALLOCATION Types of Departments 1.Producing departments: directly responsible for creating the products or services sold to customers 2.Support departments: provide essential services for producing departments •First step in cost allocation is to determine what the cost objects are • Usually the cost objects are departments LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION FOR A MANUFACTURING FIRM AND A SERVICE FIRM LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.1—EXAMPLES OF DEPARTMENTALIZATION FOR A MANUFACTURING FIRM AND A SERVICE FIRM (CONTINUED) LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.2—STEPS IN ALLOCATING SUPPORT DEPARTMENT COSTS TO PRODUCING DEPARTMENTS LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.3—EXAMPLES OF POSSIBLE ACTIVITY DRIVERS FOR SUPPORT DEPARTMENTS LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHOOSING A SUPPORT DEPARTMENT COST ALLOCATION METHOD Sequential Method of Allocation • Recognizes all interactions of support departments • The usage of one support department by another is used to determine the total cost of each support department •The total cost reflects interactions among the support departments • Then, the new total of support department costs is allocated to the producing departments LO-3 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHOOSING A SUPPORT DEPARTMENT COST ALLOCATION METHOD Total Cost of Support Departments Total cost = Direct costs + Allocated costs • Each equation, which is a cost equation for a support department, is the sum of the department’s direct costs plus the proportion of service received from other support departments LO-3 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.9—COMPARISON OF SUPPORT DEPARTMENT COST ALLOCATIONS METHODS USING THE DIRECT, SEQUENTIAL, AND RECIPROCAL METHODS LO-3 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use DEPARTMENTAL OVERHEAD RATES AND PRODUCT COSTING • After allocating all support service costs to producing departments, an overhead rate is calculated for each department = Allocated service costs + Producing department overhead costs Measure of activity (direct labor hours, machine hours) • The accuracy of product costs depends on the accuracy of the assignment of overhead costs LO-4 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES • Joint Products are two or more products produced simultaneously by the same process up to a ‘split-off’ point • The split-off point is the point at which the joint products become separate and identifiable • Joint or main products have relatively significant sales value LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.10—JOINT PRODUCTION PROCESS LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Cost Separability and the Need for Allocation •Separable costs are easily traced to individual products and offer no particular problem • If not separable, they are allocated to various products for various reasons Cost allocations are arbitrary LO-5 â 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 7.11—INDEPENDENT MULTIPLE-PRODUCT PRODUCTION USING THE SAME MATERIAL LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Accounting for Joint Product Costs •Joint costs must be allocated to the individual products for purposes of financial reporting •Several methods have been developed to allocate joint costs • • • • • Physical units method Weighted average method Sales-value-at-split-off method Net realizable value method Constant gross margin method LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Physical Units Method •Joint costs distributed on the basis of a physical measure—pounds, tons, gallons, board feet, atomic weight, or heat units Weighted Average Method •Uses weight factors (like amount of material used, time consumed, and size of unit) to distribute joint costs LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Sales-Value-at-Split-Off Method •Allocates joint cost based on each product’s proportionate share of market value or sales value at the split-off point •The higher the market value, the greater the share of joint cost charged against the product LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Net Realizable Value Method •Used if there is no ready market price for the individual products at the split-off point •First, a hypothetical sales value is obtained for each joint product by subtracting all separable (or further) processing costs from the eventual market value •Then, use the net realizable value method to prorate the joint costs based on each product’s share of hypothetical sales value •Useful when one or more products cannot be sold at the split-off point but must be processed further LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Constant Gross Margin Percentage Method •Recognizes that costs incurred after the split-off point are part of the cost total on which profit is expected to be earned •Allocates joint cost such that the gross margin percentage is the same for each product LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ACCOUNTING FOR JOINT PRODUCTION PROCESSES Accounting for By-Products •A secondary product recovered in the course of manufacturing a primary product •Obtained from joint production processes that have relatively little sales value •Two methods of accounting for by-product sales • Credit by-product revenue to ‘Other Income’ or ‘Sale of By-Product’ • Reduction of the joint costs allocated to the main products by the amount of the by product revenue LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use END OF CHAPTER © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... classroom use AN OVERVIEW OF COST ALLOCATION • A means of dividing a pool of costs and assigning those costs to various subunits • Does not affect the total cost • Amount of cost assigned to the subunits... DEPARTMENT COST ALLOCATION METHOD Total Cost of Support Departments Total cost = Direct costs + Allocated costs • Each equation, which is a cost equation for a support department, is the sum of the... DEPARTMENT’S COSTS TO OTHER DEPARTMENTS Multiple Charging Rates •The allocation of fixed costs follows a three step procedure • Determination of budgeted fixed support service costs • Computation of the